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Thursday, November 13, 2008

Massive collapse in shipping market

The Baltic Dry Index is not something to do with temperance movements in Lithuania – it is the measure of the cost of moving cargo around the world by sea. And it has collapsed by over 90% since May 2008. This is a measure of the downturn in world trade in raw materials, and an indication of the seriousness of the squeeze on the ‘Real Economy’ in the goods that can be produced from these raw materials.

Put simply, the cost of shipping has dropped through the floor. Sending a tonne of iron ore from Brazil to China in early June would have set you back more than $100 (£62) per tonne, or around $15m per voyage. But freight rates have now dropped to only slightly over $10 per tonne, or just $1.5m for the 70-90 day journey.

As if that wasn't dramatic enough, the drop in daily charter rates is even sharper. At the peak of the market, a 170,000-tonne Capesize bulk carrier was hired out at the eye-watering daily rate of $234,000. At the beginning of this week, it was $5,611 – a fall of nearly 98 per cent.Peter Kerr-Dineen, chairman of Howe Robinson shipbrokers, said: "The scale of change in rate is utterly staggering – the market has come down from super-boom territory to pretty close to bust, effectively in two months."Independent 6 November 2008

(Capesize means a ship that cannot pass the Suez or Panama canals)

And why is this important?

The wheels of international shipping are greased with "letters of credit" issued to buyers of bulk cargo by their banks. These guarantee the value of the shipment once it is in transit but before it is delivered. The problem is that the credit crunch, with the resulting liquidity problems in the international banking sector, is taking its toll on the availability of these entirely routine instruments. "We have the hugely worrying and unprecedented development where there are perfectly creditworthy shippers and receivers unable to open perfectly standard letters of credit," Mr Kerr-Dineen said.Cargos are sitting on docksides because the finance is not available to ship them, with the gravest implications for the future. "This is a nuclear bomb in the freight market, and in world trade," Mr Kerr-Dineen said. "Liquidity has to return because if there is insufficient money to provide standard finance, world trade will be sharply cut back and economic growth will implode."

This will impact on the import of food into the UK, amongst other consequences.Discussed further in a blog on the Independent by Jeremy Warner.

Note that this discussion illustrates cases where hedge funding is a good thing, allowing risk sharing and freeing up commerce – the credit crunch has frozen Hedging operations which is why there are problems.

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